CEFs Flourish Amid Strong Stock Market in 2024

This year has been positive for the stock market, and closed-end funds (CEFs) yielding over 8% have also thrived. It’s no surprise; many CEFs invest in stocks and bonds from publicly traded companies, so when stocks perform well, CEFs usually follow suit.

Strong Performance in CEFs

Source: CEF Insider

According to the proprietary indexes utilized by my service, CEF Insider, the equity sub-index leads with a remarkable 21% total return year-to-date. Corporate bonds follow closely at 14.3%. Municipal bonds, known for having lower volatility, have returned 6.6%, while foreign assets have risen by 9.4%.

Overall, CEF investors have benefited, particularly from high average yields of 8.2%. Yet, some funds have experienced downturns this year, despite generally rising profits across the board. It’s essential to explore the reasons behind these declines.

Examining underperforming CEFs will help identify funds to avoid in the future, and may even reveal buying opportunities if these funds have hit rock bottom.

CEF #1: Trouble for the Mexico Fund

We begin with the Mexico Fund (MXF), which I rarely discuss. One positive aspect is its 6.5% yield, which has been increasing since the pandemic. Unfortunately, this dividend isn’t enough to offset a decline in the fund’s market price this year, leading to a lower total return.

MXF’s Quick Decline

Over the past decade, MXF has struggled. It seemed to turn around earlier this year with a 2.7% annualized return after years of losses. Sadly, that gain has evaporated, and the fund now faces a 25.1% annualized loss for 2024, even taking into account its distributions.

Promises Followed by Losses

This decline began in spring, primarily due to Mexico’s low growth projections, with expected decreases from 3.3% in 2023 to 1.6% in 2024. Potential trade tariffs on U.S. exports only compound the risks facing investors in funds like MXF.

CEF #2: Highland Opportunities Faces Challenges

While MXF’s troubles stem from external trends, the Highland Opportunities and Income Fund (HFRO) has seen a price decline of 19.5% year-to-date due, in part, to management decisions. As of now, this is based on the fund’s market price-based total return (represented by the purple line below).

Interestingly, HFRO’s total return based on net asset value (NAV), which includes dividends, remains positive (illustrated by the orange line). Since CEFs have fixed share counts, discrepancies between NAV and market price can produce opportunities for investors.

HFRO’s Mixed Performance

Despite the relative stability in HFRO’s market price since summer, management has options to enhance returns. The fund’s name, “Highland Opportunities,” implies potential investments in a range of real estate and debt options, alongside equities. What has hindered this fund from making progress?

Upon review of HFRO’s key holdings, we notice that a significant portion of the investments comes from NexPoint properties:

Source: NexPoint Asset Management

While NexPoint likely believes their assets offer prime investment opportunities, the expected returns for investors have not materialized. The market’s perception reflects this, as HFRO’s discount has widened from 40% at the start of 2024 to over 50% now. Although this 8.7% yield could attract bids, significant gains remain improbable unless management alters its approach.

CEF #3: Underperformance for the Morgan Stanley China A Share Fund

The Morgan Stanley China A Share Fund (CAF) has become the third-worst performer in 2024, down 2.7% as of now. Oddly, this particular CEF is not focused on generating major income, as it only provides one varying distribution per year, translating to a yield of just 1% based on the last 12 months.

CAF’s decline cannot be attributed to unfavorable macroeconomic factors, unlike MXF. CAF invests in a market—China’s—that has largely prospered this year.

CAF’s Underwhelming Returns

While management decisions play a role in this underperformance, it’s worth noting CAF’s total NAV return is nearly up 3%. Similar to HFRO, CAF’s market position has also slipped, resulting in a larger discount during the year, currently at a markdown of 18.5%.